3/9/2012 6:45 PM ET|
Are you in the IRS' cross hairs?
High earners and workers who receive a lot of their pay in cash are obvious targets, but other factors can also increase the chance that your tax return will be audited.
The Internal Revenue Service has a new list of audit targets this year. Are you feeling lucky?
Do you belong to a partnership or have an S corporation (in which income passes through to the owners), or do you receive income from a trust?
If so, the IRS will be interested in your tax return. That doesn't necessarily mean you're going to be audited. But you're in the tax agency's cross hairs, and the big revenue collector at the Fed cares about your return.
This year's IRS focus will be on high-income taxpayers and those with incomes from flow-through entities such as S corporations. If your income was $250,000 or more, you're a target. If you had total positive receipts (wages, interest, dividends, etc.) of $1 million or more, you're a target.
If you didn't file a past return or have an unreported financial account overseas, they're coming to get you, and they're gonna be mean.
Other IRS targets
Then there are the traditional targets. Taxpayers who receive much of their income in cash are traditionally on the radar screen of IRS agents looking for unreported income. Be prepared to defend any non-income deposits (gifts and transfers, for example) into your accounts. If you're a small-business owner or self-employed, make sure your "business" car doesn't wind up on your kid's college campus each semester. Be prepared to substantiate your deductions.
Even if you're not in one of the above target groups, you're not necessarily off the hook. Some returns are randomly selected. But most "winners" of the audit lottery are identified by the tax agency's discriminant-function program.
Under that program, IRS has created a number of composite hypothetical taxpayers. The agency's computers compare your return with those of the hypothetical taxpayers. The further your return is from the statistical norms, the more the computer clicks. And, the more the computer clicks, the higher the probability your return will be kicked out for review.
The table below gives average itemized deductions for 2009 returns filed in 2010. If your deductions are above average, the IRS is more likely to notice you.
|US taxpayers' average deductions|
|Adjusted gross income||Interest||Taxes||Charity||Medical|
|$250,000 and up||$25,227||$48,317||$18,488||$38,149|
Regardless of the averages, deduct only the expenses you actually incurred. If you spent more than the average, claim it. Just be prepared to substantiate your numbers.
The details of the IRS discriminant-function program are a secret. It includes more than just raw numbers. For example, if your tax return shows a ZIP code from a low-income neighborhood and you deduct a charitable contribution of $10,000, regardless of your adjusted gross income, the computer is going to notice. That doesn't mean you're going to be audited, but the probability has soared.
Want to play the audit game? The IRS audited 1,581,394 individual tax returns in the fiscal year that ended Sept. 30, 2010. That was a rate of 1.1%, up from 1.0% the year before. But only 22% of the fiscal 2010 examinations were face-to-face audits. The rest were correspondence exams.
Of returns showing income of $200,000 or more, the audit rate was 3.1% in fiscal 2010, up from 2.8% the year before.
Taxing times for the IRS
The IRS itself is in trouble. Though Congress has increased the agency's responsibilities -- adding health care oversight and administration of a program that requires credit card reporting, for example -- budget and staffing issues have exploded into problems. At the end of 2010, the IRS had 94,346 employees. But more than half of them were at least 50 years old, and 39% of IRS managers were eligible for retirement.
And a $300 million budget cut, to $11.8 billion, this fiscal year could cost the agency thousands of jobs and cause cutbacks in audit and collections actions.
Unless you fall within the specific targets or have substantial income, I'm betting that the probability of an IRS audit will go down this year. This is one of those lotteries that you don't want to win. How lucky do you feel?
Jeff Schnepper is the author of the best-selling book "How to Pay Zero Taxes," which is in its 30th edition. He is a former professor of taxation, accounting and finance. Schnepper now has a full-time tax planning and legal practice in Cherry Hill, N.J. Click here to find Schnepper's most recent articles.
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